Overview



December 13, 2005

Research Associate: Manisha Sadhwani, M.A., M.Sc.

Editor: Nachiket Moghe, CFA

Sr. Editor: Ian Madsen, CFA imadsen@ 800-767-3771 x417

155 North Wacker Drive ( Chicago, IL 60606

Charles Schwab Corporation (SCH – NYSE) $15.10

Note: All new material since last report is highlighted.

Reason for Report: Mid-quarter update Previous Edition: October 24, 2005

Overview

San Francisco, California-based Charles Schwab Corporation (SCH), through its operating subsidiaries, provides securities, brokerage and financial services to individual investors and independent investment advisors who work with them. With over 7 million individual investors’ accounts and $1 trillion in client assets, Charles Schwab is one of the nation’s largest financial services firms. Its subsidiary Charles Schwab & Co. provides a complete range of investment services and products (including an extensive selection of mutual funds), financial planning and investment advice, retirement plans; referrals to independent fee-based investment advisors; and custodial, operational and trading support for independent fee-based investment advisors. Its subsidiary Charles Schwab Bank, N.A. provides banking and mortgage services and products. The corporation’s other operating subsidiaries include U.S. Trust Corporation, which provides banking and mortgage services and products. The Charles Schwab, U.S. Trust, and CyberTrader websites can be reached at , and , respectively. SCH operates on a calendar year basis.

|Key Positive Arguments |Key Negative Arguments |

|Growth Opportunities |Macro Issues |

|Expected solid growth in asset management & administrative fees as well|Depressed equity market environment over a sustained period |

|as net interest income. |High energy prices could slow fund inflow. |

|New commercial bank strategy begins to pay off with significant growth |E broker price war continues |

|opportunities. |Uncertainties inherent in retail bank expansion |

|Entering a growth phase, this provides more earnings visibility going |Increasing interest rate risk |

|forward. |Fundamentals |

|SCH has strong credentials to excel in the e-brokerage space. |Low account profitability remains an issue |

|It is well poised to benefit from a retail recovery. |Net account attrition is a persistent point of concern. |

|Fundamentals |Pricing pressure is leading to significant account attrition. |

|Meaningful topline growth led mainly by growth in its bank, a more |Low trading volumes and poor investor sentiment could negatively impact |

|active bank-sweep program and recent cost-cutting efforts. |earnings. |

|Topline growth being converted into bottomline is another significant |The positive momentum in the business will be offset by the announced |

|development. |pricing reductions. |

|Share repurchase expected to continue. | |

|Less reliance on trading revenue. | |

|Operating improvement expected in coming quarters. | |

|Continued expense discipline. | |

|Improving outlook at the U.S. Trust operations. | |

|Momentum in asset gathering to continue. | |

Capital management has become a priority over the past year for SCH. Capital expenditure was limited to $25 million and $190 million of common stock was repurchased in 3Q05, which helped ROE to reach the highest level since at least Q1 2000.

Sales

The tables are current as of 12/13/05. Please refer to the separately published spreadsheet for additional details and updated forecasts.

Prior to the Q3 earnings release, the consensus was calling for 6.9%, 4.8%, and 8.6% growth in total net revenues in Q4, ’05, and ’06, respectively. Following the release, the forecasts for Q4, ’05, and ’06 increased to 11.4%, 6.6%, and 10.0%, respectively. In this mid-quarter update, the growth forecasts for total net revenue decreased to 11.2% and 9.6% for Q4 and ’06 respectively, while the same for ’05 remained unchanged at 6.6%.

|($ in millions) |

|Positive |3 |

|Neutral |11 |

|Negative |2 |

|Average Target Price |$14.85↑ |

|Digest High |$17.50 |

|Digest Low |$9.60↑ |

|Number of Analysts |16 |

The risks to the target price include a decrease in trading activity, intense industry competition, interest rate risk, credit risk, business expansion risk, regulatory risk, and poor investor sentiment.

Please refer to the separately published spreadsheet for additional details and updated forecasts.

Capital Structure/Solvency/Cash Flow/Governance/Other

Capital management has been prioritized over the past year for SCH. Capital expenditure was limited to $25 million and $190 million of common stock was repurchased in 3Q05, which helped the ROE to reach the highest level since at least Q1 2000. Return on equity was reported at 19% in the quarter, up from 17% in the prior quarter. However, management did not provide any insight into its future actions regarding share repurchases, which leaves $260 million left on its remaining authorization.

On October 20, 2005, the Board of Directors of SCH declared a 13.6% increase to the quarterly dividend on the company's common stock to $0.025 a share. The dividend is payable November 23, 2005 to stockholders of record on November 9, 2005.

One analyst (Fox Pitt) believes there is a possibility of a hostile takeover as Schwab has many of the characteristics including excess capital and debt capacity, has been ineffective with acquisitions, poor cost control, strong brand equity, no succession plan, and no strategy to deter a takeover.

One analyst (Wachovia) notes that it appears that SCH will plow its new earnings power back into the business. The company announced that it plans to launch a new "Talk To Chuck" based marketing program and also eliminate account service and order handling fees on the 650,000 accounts with less than $25,000 in assets. This would add $20-25 million to Q4’s ad budget.

According to one analyst (Merrill), the firm’s bank platform appears poised to finally contribute to meaningful corporate profit growth. The expiration of three-year capital “training wheels” on SCH’s relatively new bank charter is slated for April ’06 whereby mandatory Tier 1 capital ratios will decline from 8% to 6%. Concurrently, the firm is taking steps to expedite the transition of customer sweep balances from MMFs to FDIC-insured deposits at the bank.

On November 15, 2005, the New York Stock Exchange announced that it has censured and fined SCH $1 million for supervisory control issues and for its failure to protect client assets. The fine does not have a material effect on earnings on a per share basis. Management has agreed to retain an outside consultant to review its policies and procedures. The violations were reported to have occurred from 1998 to 2003 and relate to non-employee investment advisers outside Schwab. The outside investment advisers allegedly moved customer assets by using forged letters of authorization and

forged checks. It appears that no Schwab employee was found to be involved in the misappropriations.

Upcoming Events

|Events |Dates |

|Q4 earnings release |Mid January |

|FOMC meeting |January 31 |

|FOMC meeting |March 28 |

Long-Term Growth

Schwab has several initiatives aimed at fostering growth. Charles Schwab Bank is one of the long-term projects. The objective is to gain a greater share of clients’ wallets by providing a greater array of services. Mortgage lending could be a strong growth area for SCH in its native California market over the long term, and any deposits gathered represent a cheap source of capital. Schwab’s asset gathering has been consistently strong over the years. Directing the energy and doing it profitably will be the key.

One analyst (CIBC) likes the growth story and believes revenue has long-term potential for growth based on the mix of client assets. Another analyst (Smith Barney) believes that US Trust is an integral part of the Schwab franchise and the new management team is determined to increase the growth and profitability of this business.

Regarding the Bank sweep program, one analyst (Friedman, Billings) believes the most significant growth opportunity for the company for the next three years lies within the Charles Schwab Bank subsidiary. While still early in the process, they believe Schwab could potentially grow its balance sheet by $40B supported by bank sweep deposits, simply by tapping into existing and future customer cash balances. Another analyst (Lehman), however, is cautious regarding the banking sweep program as they expect its profit potential to be constrained by the above-average price sensitivity of its legacy customer base.

On October 21, 2005, SCH conducted a fall business update. The main theme management communicated was their belief that they are at another important crossroad for the firm. The focus is now on profitable growth with the multi-year restructuring turnaround behind them. With the trading side of the business clearly a commodity, the differentiating factors will be a combination of pricing, performance and relationships and raising the individual businesses' ROCA, or, Revenue on Client Assets. Currently, the overall company ROCA is 40 basis points with we believe an intermediate-term objective of 50-55 basis points.

One analyst (First Global) believes that SCH is readying itself well for an excellent run in the e-brokerage space by improving itself on key operating metrics, cornering a higher market share, targeting relatively more client account inflows and increasing its share of the clients’ wallet, thereby continuing to swell its asset size.

Individual Analyst Opinions

POSITIVE RATINGS

Friedman, Billings – Outperform ($17 price target) – (11/15/05): The analysts believe higher trading activity, rising short-term interest rates, and a rebound in the equity markets should enable the company to deliver strong performance in the coming quarters.

Smith Barney – Buy ($17.50) – (11/15/05): The analysts believe that Schwab has successfully completed its turnaround and is now entering a growth phase, which provides more earnings visibility going forward. They anticipate that its faster pace of growth in client assets will continue in future.

NEUTRAL RATINGS

Fox Pitt – In Line ($14.50) – (11/15/05): The analysts believe that the SCH story has hit an inflection point as positive catalysts have been exhausted and possible headwinds lurk. They believe that the restructuring is over and now the company faces a period of reinvestment as it transitions to a more offensive strategy.

Raymond James – Market Perform – (10/18/05): The analysts are positive on the improved results given management’s refocus on delivering greater efficiency while growing assets and providing greater value to clients. They continue to see fundamental improvements at SCH.

Sandler O’Neill – Hold ($15.75) – (11/16/05): The analysts are positive on the strong October DARTs and strong net new asset growth. They have raised the price target to $15.75 from $14.70.

B. of America – Neutral ($15) – (10/17/05): The analysts believe that stronger-than-expected retail trades at SCH coming from active traders are partially a function of share gains versus peers. They raised their 2006 EPS estimate to $0.73 from $0.72.

Bernstein – Market Perform ($13.50) – (11/16/05): The analysts hold a positive outlook for the retail brokerage market. They expect increasing DARTs in Q4 2005 as retail activity remains strong. They also believe that positive earning revisions are possible as SCH’s superior operating leverage drives earnings and ROE.

CIBC – Sector Perform ($16) – (11/15/05): The analysts believe management has clearly shifted from turnaround to growth. They further believe that the fundamental drivers of revenue expansion at Schwab remain in place, which is reflected in the healthy asset inflows and trading activity.

J.P. Morgan – Neutral – (11/15/05): While the analysts believe Schwab will likely benefit from some of the improvements in retail trading activity that they expect will occur over the next twelve months, they believe some of those benefits may be muted by recently announced commission price cuts. They also believe the company will be focusing on potential growth initiatives over the next twelve months.

Keefe Bruyette – Market Perform ($14) – (11/16/05): The analysts are positive on the industry as the equity markets have improved, retail trading activity has increased, and equity fund flows have been positive. They have lowered their Q4 EPS estimate to $0.14 from $0.16 following management guidance.

Merrill – Neutral – (10/24/05): The analysts expect improved margins from incremental contributions from higher margin bank products funded by low cost bank sweep assets. Meanwhile, the institutional business momentum appears solid and less susceptible to near term market swings. They raised their 2006 EPS estimate to $0.73 from $0.66 driven by stable market backdrop, continued NII growth, partly offset by lower transaction pricing.

Wachovia – Market Perform ($13.50) – (10/17/05): The analysts believe the combination of heightened competition amongst peers and weaker macro fundamentals will continue to weigh on the pricing power in the retail investor business. They believe the firm will need a robust macro market to reach the next leg of earnings out performance as firm-specific improvements will be coming to an end.

William Blair – Market Perform – (10/17/05): The analysts are positive on the encouraging trends with respect to revenue, profitability and asset flows at SCH. They raised their 2005 and 2006 EPS estimates to $0.57 and $0.70 from $0.56 and $0.68, respectively, reflecting better operating leverage as a result of improved revenue growth and continued focus on expenses.

NEGATIVE RATINGS

Bear Stearns – Underperform – (10/24/05): The analysts are positive on the cost reductions, revenue increase, expansion of customer base and assets at SCH. They raised their 2005 and 2006 EPS estimates to $0.56 (from $0.54) and $0.62 (from $0.59), respectively, given higher estimated client assets, DARTs and margin loans.

Lehman – Underweight ($9.60) – (11/15/05): The analysts believe that a substantial gap remains between SCH's premium valuation and the real quality and pace of its earnings growth. They observe that contrary to media and analyst reports of a great turnaround at Schwab, the firm is still losing substantial ground in a highly competitive (and pricing-pressured) marketplace. They have, however, raised the price target to $9.60 from $9.50.

Copy Editor: Pushpanjali Banerjee

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